Tax Tip: A Party at Home? That's (Deductible) Entertainment!

This is the sixth article in our series of tax return tips for 2011 returns.

The days of the three-martini lunch are long gone, but savvy taxpayers can still savor plenty of tax treats for entertaining their top customers. In fact, some clients may be entitled to write-offs for hosting get-togethers at their own homes.

As a starting point, taxpayers can deduct 50 percent of entertainment costs that are "directly related" or "associated with" the active conduct of their business. To be directly related, there must be an expectation of deriving income or a specific business benefit from the activity and engage in business discussions during the activity. The entertainment must be secondary to the business purpose and, generally, be limited to those involved in the business activities.

It's more common to qualify for deductions based on entertainment associated with your business. In this case, all you have to do is hold a "substantial business discussion" directly before or after the entertainment. In other words, unlike directly related entertainment, associated-with entertainment can be purely social in nature.

If the customer you're entertaining is from out of town, the entertainment may take place the day before or after the business meeting. Thus, after negotiating a business deal on Friday, a taxpayer can host a dinner party for the customer on Saturday and deduct the allowable portion of the home entertainment.

How much can you deduct? There's no prohibition against inviting social guests like friends or neighbors to a house party, but you can't write off costs attributable to those guests. Only the portion attributable to business guests is deductible, although spouses get a free pass. You can count the "better halves" as business guests even if they have nothing to do with the business.

For example, suppose a client holds a house party following a substantial business discussion. The guest list includes the three business associates at the meeting and their spouses, a couple of friends, and you and your spouse. If the cost is $1,000, $800 of the cost qualifies for the deduction. So your client can write off $400 as business entertainment (50 percent of $800).

Finally, if a client hosts a summer barbecue or other get-together for employees, the usual 50 percent limit on entertainment deductions doesn't apply. The entire cost is deductible as long as the entire staff is invited.